The second object in protecting bank note holders, namely, to provide ultimate payment at par if immediate conversion proves impossible, is attained in several ways in the different existing banking systems, according to the local or political conditions of each country.
The simplest of these various plans is to give the noteholder no more protection than the depositor and to rely upon the business self-interest of the banker. The theory upon which this method is based is as follows: A bank note is a simple promise on the part of the bank to pay and circulates on the credit of the issuer. This credit is improved if the bank has adequate sound and liquid assets, for the bank notes together with the deposits are ultimately paid from the general assets. Fear of failure and of bankruptcy makes the banker conservative in his investments, hence the self-interest of the banker, as well as the requirements of law and government regulation, is assumed to provide adequate protection to the noteholder. This method of attaining ultimate payment at par, while theoretically sound, has proved delusive and dangerous, particularly in the early history of our state banking. It works best in old districts in which banks, chastened and taught by failures, have assumed a full responsibility for the continuous and conservative financial welfare of the district. It is also less likely to succeed in a decentralized system of note issue, where competing banks act independently and for their own advantage and exercise little or no restraint on a bank which is known to be overextended.
Where it is desired to give more protection to notes than to deposits, the notes may be given a prior hen on the general assets, that is, after the notes have been liquidated at par the depositors are entitled to the remaining assets. It is evident that by the prior hen noteholders are protected at the expense of depositors. The bank note systems of France and Canada illustrate these two schemes respectively.
In general, however, the issuance of bank notes is regulated in the interest of the holders, and these regulations are supposed to provide indirectly for security. The plans for such regulation are numerous.
One method is to restrict the issue to certain banks. The central banks of England, Germany, and France enjoy practical monopolies of issue in their respective countries; these banks are exceptionally strong and are moved by a public interest which does not generally characterize local banks. In England this restriction allocates the issues still more by placing that activity entirely in the hands of the Issue Department, a plan which results in a clear-cut separation of loans and issue, making baneful collusion of bank officers, as well as trespasses on the law, less easy and secret.
A second method is to restrict the amount of the aggregate issue. The limit may be absolutely fixed at so many milliards, as in France or Germany, or be limited according to the government debt or the issuing bank's capital, as in the United States. The limit fixed may or may not be elastic - the 5 per cent tax on the excess as used in Germany, or the Aldrich-Vreeland Currency Associations formerly used in the United States, illustrates the elastic limit. Indirect limitations may be imposed in various ways, such as by:
2. Requiring Immediate Clearance And Redemption, As In Canada.
3. Limiting The Area Of Circulation.
4. Guarding the nature of loans and assets and supervising the banks' practices through legal restraints, regulations, examinations, and reports. These methods of indirect limitation are combined in varying degrees and ways.
A third group of methods of protecting noteholders with ultimate security is to pledge special assets. The segregation of these assets, usually those of better quality than the rest, for the special security of bank notes is made to the detriment of the security for deposits. This partiality is shown to notes because legislatures, for previously mentioned reasons, regard the noteholder as a more immediate ward of the state.
The particular assets set aside for the protection of the noteholders are usually high-quality assets, such as mortgages or government bonds, and are pledged with the government, which is authorized to sell the bonds and redeem the outstanding notes. Commercial papers, such as notes and acceptances of tradesmen and manufacturers, are very serviceable assets for use as a pledge against notes, because they open a way to procure elasticity.
Another system of affording security is to have a government or other large institution or group of institutions stand guarantor of the notes issued. The security of the notes is then that of both the commercial world and the government or guaranteeing institution. The best example of this system is our national bank system, for the notes of which our federal Treasury stands practical guarantor.